Boston College, Carroll School of Management

Square’s IPO Woes

Introduction 👋

Thanks to @jjliang91 for her presentation on Square, you can read her post here. This post was inspired by the Acquired podcast where they take a deep dive into tech acquisitions and IPOs (one of which was the Square IPO).

Square has been one of the most fascinating companies in tech ever since it’s disappointing IPO in 2015. Before it’s IPO, Square was one of the hottest tech companies and had no trouble raising capital at increasingly higher valuations. Below is a timeline of their funding rounds:

November 2009: Raised $10M (Series A)

January 2011: Raised $27.5M (Series B)

June 2011: Raised $100M (Series C)

September 2012: Raised $200M (Series D)

October 2014: Raised $150M (Series E)

Despite the amount of capital raised and the traction Square was gaining, there were two key moments in this timeline that led to Square’s IPO woes.

Square x Starbucks

On August 7, 2012, Square announced that they were partnering with Starbucks to process all of its U.S. credit and debit card transactions across their 7000 locations. As part of this deal, Starbucks invested $25M, at a $3.25B valuation, and Howard Schultz (Starbucks CEO) joined Square’s board of directors. This deal was monumental at the time and launched Square into the public eye and into mainstream retail. Back then, roughly $6B flowed annually through Square’s systems. In the quarter before this announcement alone, Starbucks had generated $3.3B in revenue. After factoring in Starbucks credit and debit sales, it seems as if this deal should have elevated Square’s prominence across both small and big merchants while bolstering their revenues significantly.

Unbeknownst to Square and many others, this deal ended up being a monumental failure. By late 2014, Starbucks discontinued most of its app partnerships with Square and backed out of its contract almost a year early from when it was slated to end. The deal was supposed to last until October 1, 2016. In Square’s S-1, the initial registration form for new securities required by the SEC for public companies, revenues and transaction costs related to Starbucks were individually reported on its statement of operations, highlighting the significance and unfortunate impact of the Starbucks partnership to Square’s bottom line. In the 3 years before filing to go public, Square lost a grand total of $71M from processing Starbucks payments.

Consolidated Statement of Operations from Square’s S-1

Here are some financial figures that I calculated directly from the S-1 that help to put this supposed mega-deal into perspective:

2012

2013

2014

Starbucks Transactions as a % of Net Revenue

4.66%

20.72%

14.47%

Starbucks Transaction Costs as a % of Cost of Revenue

9.03%

33%

24.19%

Essentially, Starbucks cost Square significantly more money than it earned for every single payment. This partnership was identified as a risk factor in Square’s IPO filings because it hurt their revenue growth. To make it extra clear to potential investors, Square reiterated that it would not be renewing the Starbucks deal more than 10 times in its S-1.

Whether this was an attempt to spin the partnership as a positive or whether it was actually true, Square stated this on the Starbucks deal, “We believe this agreement was a valuable catalyst for building best-in-class enterprise infrastructure.” Despite the heavy financial losses it suffered, some analysts agree with Square’s statement about how this deal forced Square to evolve. David Rosenthal, co-host of Acquired, says that this deal transformed Square from a simple payments company to a provider of world-class tools for merchants to scale and operate their business. What’s fascinating is that after this Starbucks partnership, Square’s suite of tools was effectively able to satisfy the widely different needs of both massive enterprises and smaller local merchants, from payments to inventory management.

Series E -> IPO -> 📉

Jack Dorsey during Square’s IPO (Photo from Business Insider)

On November 19, 2015, Square had its IPO at a price of $9 per share at a valuation of $2.9B. This was a colossal disappointment since the company not only expected to price its share between $11 and $13, but in its most recent Series E round in October 2014, the company was valued at around $6B. In other words, less than a year ago, the company was worth double what it was worth at its IPO price.

Making this story even more interesting, Square’s Series E investors had something called a ratchet provision which guaranteed investors generate a 20% return at IPO regardless of the actual IPO price. Provisions like this are designed to give investors downside protection on their risky investments. Since investors had paid $15.46 per share during Square’s Series E, Square had to have an IPO price of $18.56 per share to generate a 20% return, which it didn’t. As a result, Square had to issue extra shares to its Series E investors to give them their guaranteed return. This diluted the shares of all other Square investors, which also includes founders and employees.

Oddly enough, there was a peculiar commonality between Square’s Series E round and its IPO: Goldman Sachs was a Series E investor and the lead underwriter for its IPO. At first glance, this doesn’t seem consequential or remotely out of the norm. However, what is peculiar about Goldman Sachs’s involvement with Square is that they technically had an incentive to price Square as low as possible at IPO. Why? Because the ratchet provision guarantees them a 20% return, so the lower the price of the IPO, the more stock Series E investors received. If Series E investors had held this stock, they would have made well over their 20% return. Whether they did this intentionally is mere speculation, however, this was just one of the many troubles on Square’s tumultuous road to an IPO.

Started from the Bottom 🔥

Since then, Square has recovered from its rough IPO and is currently valued over $15B. Many thought that the Square IPO was a sign of the end times for unicorns or startups valued over a $1B. In actuality, Square has a solid fundamental business that taps into a massive and still growing digital payments market. As cashless payments become the norm, Square’s total addressable market will continue to grow. The fascinating thing about Square is that its offerings complement one another and create a positive feedback loop that accelerates growth for Square and for Square customers.

Through Square Capital, Square offers customers small business loans to grow their company with the hope that this capital will grow their customer’s businesses. With this increased capital, Square customers will invest in their business, increase their revenues, and subsequently increase the number of transactions that flow through Square’s systems. This positive feedback loop is accelerated further by Square’s other products like its payroll software.

I’m a big supporter of Square because it not only has a great fundamental business model but it also enables merchants, big or small, to have world-class tools to grow their businesses. Square has beaten analyst earnings predictions and proven its doubters wrong and I look forward to seeing where and how they decide to pursue growth.

Questions 🙋

Below are some questions I’d ask on our visit to Square:

How do you think the partnership with Starbucks affected Square’s long-term growth?

Does Square view cryptocurrencies as a viable currency for transactions in the future?

If so, how long until it does?

How does the Square Cash App differentiate itself from other P2P payments platforms?

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8 thoughts on “Square’s IPO Woes”

This is awesome! Great work! I read about the disappointment among investors when the IPO price fell well below the expected, but the Starbucks partnership was something new I learned from reading your post.

I think the partnership’s positive impact in a way is true because we do see that Square has been rolling out CRM tools to work with larger businesses, and I think Square has the potential to become a powerful cloud-based EPR for businesses who don’t want to invest in capital-intensive technology infrastructure.

Great post! It is interesting to see the rollercoaster ride that a company has endured up to this point, especially the monumental failure that was the Starbucks investment. I think that Square Capital sounds like a great idea, as long as their system continues to work well. I cannot imagine how angry these small business owners would be if they main method of payment would malfunction, LOL.

Digging into the financials during this post really underscored your points! Glad to see they’ve finally nailed the business model with that positive feedback loop.
After our class discussion about VC timelines, I’m surprised to see that Square made it all the way to a Series E and then went public. I wonder if internal conversations used to center around keeping Square privately held, and then what changed that.
I’d also be interested to learn more about what went wrong with the Starbucks deal. Was it just the payment structure? If so, why did Square drastically underestimate operating costs? Were there any underlying reasons, for example poor marketing communications or app development?

The Starbucks deal is very interesting! Starbucks invested around $25 million and owned securities representing more than 27% of Square’s publicly traded stock at the peak of the partnership. But by early 2017, Starbucks had completely exited. It seems like Square struggled in trying to scale with Starbucks’s sales and that led to processing costs that were higher than the sales. The last year of the contract was actually the best, finally showing a gross profit, but the damage had been done and both companies were ready to move on.

This is an interesting analysis, Erik! Goldman’s role in Square’s IPO is fascinating to me. It seems like quite an oversight by Square’s leaders to put Goldman in a position of such power. Perhaps, there was a strong relationship behind the scenes or the thought of an IPO created some tunnel vision.

Great post, Erik! This company certainly experienced ebb and flow. I was unaware of how significant the failed Starbucks partnership was. It looks like Square is back on their feet with the new valuation and will be interesting to see what their strategy is to remain relevant in the growing digital payments market.

Its amazing to see how the Starbucks decision seemed like such a great opportunity to elevate them to prominence, even though not the most profitable. Its really interesting to see the woes that square has had with investment bankers and VC’s alike, as everyone seemed to take a cut of their growth but them. I really like the trajectory that the company is on now, and it will be interesting to ask about Square Cash and bitcoin. Great post!